WORKINGPAPER SERIES - The Great Austerity War: What Caused the Deficit Crisis and Who Should Pay to Fix It? James Crotty
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RESEARCH INSTITUTE
POLITICAL ECONOMY
The Great Austerity War:
What Caused the Deficit Crisis and
Who Should Pay to Fix It?
James Crotty
June 2011
Gordon Hall
418 North Pleasant Street
Amherst, MA 01002
Phone: 413.545.6355
Fax: 413.577.0261
peri@econs.umass.edu
www.umass.edu/peri/
WORKINGPAPER SERIES
Number 260The Great Austerity War:
What Caused the Deficit Crisis and Who Should Pay to Fix It?
James Crotty
Professor Emeritus and Helen Sheridan Memorial Scholar
Economics Department: University of Massachusetts, Amherst
June 2011
The Helen Sheridan Memorial Lecture
Presented in Boston on April 15, 2011
I am grateful to the Helen Sheridan Memorial Scholars' Program for research support and to
Yasemin Dildar for research assistance.
1Abstract
Rapidly rising deficits at both the federal and state and local government levels, along with long-
term financing problems in the Social Security and Medicare programs, have triggered a one-
sided austerity-focused class war in the US. Similar class conflicts have broken out around the
globe. A coalition of the richest and most economically powerful segments of society and
conservative politicians who represent their interests has demanded that deficits be eliminated by
public-sector austerity - severe cuts at all levels of government in spending that either supports
the poor and the middle class or funds crucial public investment. These demands constitute a
deliberate attempt to destroy the New Deal project, begun in the 1930s, whose goal was to
subject capitalism to democratic control. The right-wing coalition seeks to replace that project
with a modernized version of the 'free-market' capitalism of the 1920s. In this paper I argue that
our deficit crisis is the result of a shift from the New-Deal-based economic model of the early
post-war period to today's neoliberal, free-market model, a shift initiated under Ronald Reagan
and continued under the presidents who succeeded him. The new model has generated slow
growth, rising inequality and rising deficits. Rising deficits in turn created demands for austerity.
After tracing the long-term evolution of our current deficit crisis, I show that this crisis can be
resolved by raising taxes on upper-income households and large corporations, cutting war
spending, and adopting a Canadian or European style health care system. There is no need to
accept austerity. Calls for austerity should be seen as what they are - an attack by the rich and
powerful against the basic interests of the American people.
Key Words: deficit crisis; fiscal crisis; austerity; Social Security crisis; health care crisis.
JEL Codes: E60; E62; H60.
21. Introduction.
We have reached what may be a crucial point in the evolution of the political economy of
the United States. Rapidly rising deficits at both the federal and state and local government
levels, along with long-term financing problems in the Social Security and Medicare programs,
have triggered a one-sided class war. The richest and most economically powerful segments of
society, in concert with conservative political forces, have demanded that the deficits be
eliminated by public-sector austerity - severe cuts at all levels of government in spending that
either supports the poor and the middle class or funds crucial public investment in education,
health care, infrastructure and technology. This has been accompanied at the state and local level
by attacks on public-sector unions whose membership now exceeds that of collapsing private-
sector unions. Simultaneously, a right-wing coalition of the rich, large corporations, and
conservative politicians demands huge tax cuts for wealthy households and corporations.1 For
example, the Republican controlled House of Representatives recently proposed $4.2 trillion in
regressive tax cuts that would ratchet up political and economic pressure to further decimate
government social and investment spending by creating even larger deficits. This is an example
of the conservative “starve the beast” strategy that calls for sustained regressive tax cuts under
any and all fiscal circumstance to force all spending other than on defense and programs that
enrich corporations to implode.2 Similar austerity pressures have developed around Europe as
well. Austerity-focused class warfare has begun in much of world.
The current austerity war is an attempt to destroy the economic system created in the US
and elsewhere in the aftermath of the Great Depression and World War II. This economic model
is called social democracy, or democratic capitalism, or regulated capitalism, or the mixed
economy. In the US, the foundations of the new model were built in the 1930s with the creation
of FDR's New Deal. Social democratic systems rely heavily on markets, but market activity is
1
In this paper, the term "right-wing coalition" refers to an alliance among wealthy individuals, corporations and
political conservatives. Starting in the late 1970s, this coalition began to include an increasing percentage of
Democratic politicians.
2
Note that while Republicans claim to abhor deficits, their desire for tax cuts for their supporters has always
trumped concern with deficits. As Herbert Stein, chairman of the Council of Economic Advisors under Nixon,
argued in an excellent book called The Fiscal Revolution in America (AEI Press, 1996, revised edition), Republicans
have never opposed a tax cut for their constituents no matter what the fiscal implications.
3subject to the guidance and ultimate control of large and powerful democratic governments that
represent the interests of the majority. The government is expected to: invest in infrastructure
and technology; support crucial economic sectors subject to market failure - such as education,
health care and housing; regulate business; provide an expanding social safety net to assist those
who do not fare well in the market system; use the tax system to generate the revenue required to
fulfill these obligations and limit inequality; and ensure that the economy generates adequate
employment at rising wages through macroeconomic policy. The government is also expected to
provide a supportive environment for the union movement so that it can serve as an effective
counter-weight to business and the wealthy in the workplace and in the political arena. History
suggests that unless countered by labor and other progressive social forces, the interests of large
corporations and the rich will eventually dominate the political process. In this paper the term
New Deal refers primarily to the general social democratic model that began to develop in the
1930s, rather than more narrowly to FDR's specific policies.3
Conservatives argue that austerity programs will raise the growth rate, lower
unemployment and thereby lower the deficit. But in fact they generate the opposite results. Cuts
in government spending reduce total spending on goods and services. This lowers employment
and income in the economy, which in turn lowers tax revenue and increases deficits. The
adoption of austerity programs across the globe threatens to sink economies deeper into
recession or even depression, perhaps triggering yet another global financial crisis. However, I
will not focus on this pressing danger of austerity here. We need a serious jobs-creation program
over the next several years, but this program cannot be built on the deep cuts in public spending
and regressive tax cuts demanded by the right-wing coalition.
This paper makes three main points. First, today's austerity war has a deeply-rooted
history. It is the culmination of at least eight decades of right-wing efforts to destroy the general
social democratic economic model initiated through the creation of the New Deal.
Second, our current government debt crisis is the result of right-wing economic policies
implemented since the Reagan administration. These policies not only led to a deterioration in
economic performance, they generated large budget deficits as well. Our debt to GDP ratio was
very low before 1980, but, with the exception of the latter part of the Clinton presidency, it has
3
The form of social democracy created in the US was much weaker than many of the social democratic systems in
Europe.
4been rising rapidly ever since. It has tripled since Reagan took office. Rising deficits are an
integral part of the economic system created by Reagan and his followers. Slow growth and tax
cuts generated rising deficits, and in the peculiar logic of right-wing economics, these deficits
trigger demands for additional regressive tax cuts. Conservative economists argue that tax cuts
on business and the rich increase the rate of economic growth. The fact that their thesis has
repeatedly been demonstrated to be false is politically irrelevant. Conservative politicians use a
strategy in which rising deficits are a means to exert financial and political pressure to cut
government spending on productive investment and shrink the social safety net - cornerstones of
the New Deal. At least untill now, attempts to slash social spending on major New-Deal-type
programs such as Social Security and Medicare have not been politically feasible, and military
spending has remained bloated. Since tax cuts have not been matched by substantial spending
cuts, the result is endless deficits. However, the current debt crisis is severe enough that it has
created conditions in which fundamental New Deal programs may well be destroyed.
Third, rather than attack the causes of the deficit crisis - slow growth under the right-wing
economic model, the radical deregulation of financial markets, endless regressive tax cuts and
excessive defense spending on wars of choice, both Democrats and Republicans have instead
proposed substantial spending cuts. The Democrats offer moderate austerity and the Republicans
demand unrelenting austerity designed to destroy the entire New Deal project. Both parties also
propose regressive tax cuts that will increase deficits, ratcheting up the pressure for more
austerity. Democrats propose substantial tax cuts while Republicans demand huge tax cuts.
This increasing political pressure to destroy the foundations of the New Deal is bizarrely
paradoxical. The right-wing coalition is on the verge of succeeding in its eighty-year quest to
defeat the New Deal, not in spite of, but because it produced three-decades of economic failure
and exploding deficits. It is the huge rise in government debt generated by the right-wing model
that created the recent financial and political crisis that in turn spawned a wide-spread demand
for austerity. The right-wing coalition appears to have succeeded through failure; the worse the
economy performs under its leadership and the more the deficits grow, the greater the likelihood
it will achieve its ultimate goal.4
4
There is another important paradox associated with the deficit crisis. Financial markets are thought to be the
ultimate enforcer of austerity. If the government does not quickly resolve both intermediate and long-run deficit
52. Understanding Today's Austerity War Requires an Economic and Political History
Lesson.
To understand the kind of political economy that today's right-wing coalition wants to
achieve in the US, consider the boom of the second half of the 1920s. In that era there was little
regulation of business, very low taxes on business and rich households, a crippled union
movement, a powerful financial sector that rained money on the wealthy, and a political system
dominated by economic elites. From 1923 to 1929, 70% of the growth in income went to the
richest 1% and only 15% went to the bottom 90% of the income distribution. This was a right-
wing dream world.
This kind of extreme 'free-market' economic system is inherently subject to system-
threatening booms and crashes. A financial crisis developed in late 1929 that eventually became
a financial collapse accompanied by a severe depression. The unemployment rate hit 25% in
1933, while real GDP collapsed by 27% from its 1929 level. This economic disaster led to
serious social and political unrest that called the very existence of capitalism in America into
question. Trade union militancy exploded while communist, socialist and semi-fascistic
movements sprung up across the country. The idea that unregulated capitalism posed an extreme
danger to the economy and society became the dominant view. FDR and the Democratic Party
took control of the government in 1933 and began to implement a series of programs that became
known as the New Deal. They included strict regulation of financial markets, creation of the
Social Security program, support for the rising industrial union movement, large public
employment programs, deficit-financed stimulus spending of various kinds, and the beginning of
problems, it is argued, it will lose the "confidence" of financial markets. When that happens, interest rates on our
huge public debt will spike, causing interest payments to rise to such a high percentage of GDP that there will be no
choice but to drastically slash spending. Almost all the deficit reduction work will have to be done through spending
cuts because financial markets do not like high taxes on corporations or the rich. Financial markets are dominated by
corporate behemoths that are run by and for the richest people in America.
This is paradoxical because financial markets recently self-destructed as the result of a frenetic pursuit of
profits and bonuses in a largely unregulated environment, and had to be rescued from insolvency by the very
governments they now threaten to wreak havoc upon. Giant financial firms seem to have a kind of structural
blackmail power over governments. No matter how much excessive risk they take in pursuit of short-run profits and
bonuses, governments believe they have to bail them out or their collapse will bring the rest of the economy down
with them. When they do implode and trigger a deep recession that causes government deficits to rise, financial
markets get control over government economic policy and use it on behalf of the rich. The most extreme cases of
this paradox have occurred in smaller countries like Greece, Ireland and Portugal and the not so small economy of
Spain, where the IMF, the EU and large banks demand extreme budget cuts and privatization of public assets at fire
sale prices in return for loading these heavily-indebted countries with even more debt.
6a system of unemployment insurance. The New Deal helped stop the collapse of the economy;
real GDP in 1936 and 1937 exceeded its 1929 value. But it was too weak to restore full-
employment and general prosperity. That required the central planning and huge government
spending of World War II.
The economic role of government grew substantially after World War II. Federal
spending was about 3% of GDP in 1929, but this increased to 16% in the 1950s. Social Security
was expanded, Medicare and Medicaid were created, and various income security programs were
instituted that expanded the social safety net. Union membership peaked at 34% of all workers in
1954. Unions were especially strong in America's dominant industries and their contracts
influenced wages and working conditions in non-union companies. They became an important if
junior partner in the Democratic Party. Unions not only provided the Democrats with financial
support, they also mobilized millions of families to vote for Party candidates. They were the
most important constraint on the power of corporations and the rich in both in the political arena
and in the economy, and the most important force pushing for government economic policies in
the interest of the poor and the emerging middle class. Indeed, unions and the New Deal largely
created the great post-war bulge in the ranks of the American middle class. Later, when the union
movement weakened, there was no other organized force able and willing to perform this
function.
US elites were split on the question of whether to accept the main components of the
New Deal in the early 1930s, but the strength of right-wing resistance increased in the latter part
of the decade as the danger of mass rebellion against capitalism ebbed. The right-wing coalition
abhorred the New Deal because, in their view, it interfered with the freedom of private property
through regulation of industry, the confiscation of private wealth through income taxation (which
did not exist prior to 1916), and the destruction of the perfect efficiency of the idealized vision of
the free market system they revered. Corporations hated unions because they believed that they
interfered with the right of owners to run their businesses as they saw fit, eroded efficiency,
limited freedom of contract, lowered profits, and opposed corporate interests in the political
process. The coalition hated Social Security and unemployment insurance because they believed
economic security should be gained through work and property ownership, not through
government handouts, unless, of course, they are on the receiving end of the handouts. They
7opposed a government commitment to pursue full-employment because fear of job loss helps
sustain business's power over their workers.
In other words, the coalition wanted to restore the 1920s regime. Their goals were clear:
end government regulation of business, cut or eliminate taxes on corporations and the rich,
destroy the union movement, slash government social spending, restore the share of the top 1%
of the income distribution to pre-depression levels, and get government back under elite control.
Much of the opposition to the New Deal was based on economic self-interest, but there
were powerful moral and ideological dimensions as well. The New Deal was seen not just as a
threat to profit, but as a threat to deeply-held values and a way of life, a fact stressed by Kim
Phillips-Fein in her excellent study of the history of right-wing resistance to the New Deal from
the 1930s through the Reagan years.5 The right-wing forces that hated the New Deal:
dreamed of a return to the low-regulation, low-tax economy of the 1920s or even the late
19th century. … They feared the power of the state and the threat of economic
redistribution. They believed that at the heart of the New Deal and the labor movement
was an excess of democracy - that the organization of working-class people into labor
unions led to the rise of the welfare state and the perversion of the market economy. …
They believed that the free-market was equivalent to freedom itself, that regulating the
market meant surrendering political liberty as well as economic strength. For them, the
turning back of the New Deal was a question not only of the bottom line but of the
deepest social principles. They had [a deep-seated] antipathy toward social democracy.
(Phillips-Fein, p. 269)
The right-wing coalition's effort to defeat or defang social democracy began in the 1930s
and continues to this day. It had many victories along the way. The Taft-Hartley law passed in
1947 was a major achievement. It banned important union weapons such as sympathy strikes and
secondary boycotts, permitted state right-to-work laws that outlawed union shops, and attacked
radical union leaders through mandatory loyalty and anti-communist oaths. Hamstrung by Taft-
Hartley and with only limited success in organizing the anti-union South and white collar
workers, union membership rates began a slow rate of decline from their early 1950s peak. Still,
organized labor remained a formidable force for many decades.
The Goldwater presidential campaign in 1964 was perhaps the high water mark of anti-
New-Deal efforts until the late 1970s. The right-wing coalition's problem was that the ever-
5
Kim Phillips-Fein, Invisible Hands: The Businessmen's' Crusade Against the New Deal, W.W. Norton, 2009.
8expanding role of government in the economy was very popular not only because it helped
restrain the ravages of the Great Depression, but also because it created a very prosperous
economy from WWII through the mid 1970s - the so-called 'Golden Age' of modern capitalism.
The rate of economic growth was high, unemployment was low, real wages and family incomes
rose rapidly, and inequality plummeted - from a peak of 24% in 1928, the income share of the
top 1% fell to around 10% by the late 1940s, where it remained until Ronald Reagan took
office.6 Much of the business sector distanced itself from coalition efforts to overthrow the New
Deal in the 1950s and 1960s because profits were so high. President Eisenhower expressed
mainstream Republican acceptance of substantial portions of the New Deal in a 1954 letter to his
brother:
Should any political party attempt to abolish Social Security, unemployment insurance,
and eliminate labor laws and farm programs, you would not hear of that party again in
our political history. There is a tiny splinter group, of course, that believes you can do
these things. Among them are H. L. Hunt (you possibly know his background), a few
other Texas oil millionaires, and an occasional politician or business man from other
areas. Their number is negligible and they are stupid. (In Phillips-Fein, p. 56)
Note that the positions Ike describes as "stupid" are key objectives of today's Republican Party.
Programs in the tradition of the New Deal continued to expand in the 1970s. In terms of
the economic role of the government, President Nixon was an activist who was more progressive
than most of today's Democrats.
The surge of government activism accelerated under Nixon… Nixon, not Johnson,
oversaw the most rapid increase in domestic spending since the New Deal. He signed on
to a huge expansion of Social Security, as well as to the creation of a national food
stamps program. Nixon also approved the transformation of Old Age Security Assistance
into a much larger and fully national Supplemental Security program. Nixon, not
Johnson, signed into law the huge extensions of regulatory policy that marked this
period, creating the Environmental Protection Agency (1970), the Occupational and
Health Administration (1970), the National Traffic Safety Commission (1970), the
Consumer Protection Commission (1970), and the Mine Safety and Health
Administration (1973). … Compared to the leaders of today's GOP - or even many
current Democrats - Nixon looks like a full-throated Social Democrat. (Hacker and
Pierson, pp. 96-97)7
6
See http://www.stateofworkingamerica.org/charts/view/155.
7
J. Hacker and P. Pierson, Winner-Take-All Politics: How Washington Made the Rich Richer and Turned Its Back
on the Middle Class, Simon and Shuster, 2010.
9The mid to late 1970s marked a turning point in the status of the right-wing coalition in
the political process. The decade of the 1970s was economically turbulent. Jumps in oil prices hit
the economy both early and late in the decade. As a result, there were two spikes in the rate of
inflation. Since the Keynesian policy model adopted in the US relied almost exclusively on the
use of fiscal and monetary policy to alter total spending in the economy (and not on more micro-
oriented industrial policies), the government had only two choices. It could stimulate spending to
sustain growth and employment at the expense of inflation, or restrict spending to stop inflation
at the cost of rising unemployment and slower growth.8 In the wake of the first OPEC oil price
hike in 1973, it chose the latter course. The unemployment rate rose from 4.9% in 1973 to 8.5%
in 1975, a rate that was shockingly high by the standards of the Golden Age. Inflation did decline
from 1975 through 1977, but then rose again near the decade’s end with the second OPEC price
increase. Meanwhile, the fall in the growth rate, reinforced by rapidly rising imports, lowered
profits and stock prices. All this created growing discontent with the economic status quo.
Meanwhile, social unrest was stirred by racial conflict over integration, the anti-Vietnam-war
movement, and the so-called 'culture wars' - student radicalism, the women's movement, pro-
abortion struggles and a youth rebellion evidenced by 'drugs and sex and rock and roll.'
These developments led to a political alliance between resurgent right-wing economic
forces and the rapidly increasing ranks of cultural conservatives. For example, the religious right
became increasingly influential. As a result, business and other conservative forces saw a
dramatic increase in their ability to raise money to elect friendly politicians, organize massive
grass-roots pressure on all politicians, and spend money on an expanding right-wing ideological
infrastructure of think tanks and university influence. They gained increasing control of the
media - television, radio and newspapers - and used this influence to interpret economic and
political events for the public through a conservative prism. As top executives from giant
corporations began to shift toward more aggressive conservative economic positions, they
created a formidable fund raising and lobbying operation. Corporate Political Action Committees
became increasingly influential. Wealthy right-wing families such as the Ohlins, the Pews, the
Coors, the Kochs and the Mellon-Scaifes also poured money into the political process. While
8
In fact, these were not Keynes’s preferred policies. For an explanation of the more radical policies Keynes actually
supported, see James Crotty, "Was Keynes a Corporatist? Keynes's Radical Views on Industrial Policy and Macro
Policy in the 1920s," Journal of Economic Issues, September 1999, pp. 555-78.
10business and the rich provided the rising supply of money, the increasing cost of political
campaigns created a pressing demand for their funds. Republicans were overpowering
Democrats in the money wars of the late 1970s. This development came in the wake of a mass
desertion of the Democratic Party by Southern conservatives. Meanwhile, the percentage of
American workers in unions had fallen to 23%, further weakening support for New Deal
programs.
Democrats responded to this new environment by becoming more business-friendly and
more conservative on economic issues. By the late Carter administration, the right-wing coalition
was in position to begin to challenge the foundations of the post-war political economy.
1977 and 1978 marked [the start of ] the rapid demise of the liberal era and the
emergence of something radically different. … By 1978, at a time of unified Democratic control
of the House, Senate and White House, the precursors of the Reagan revolution were already
visible. Congress passed a tax bill whose signature provision was a deep cut in the capital gains
tax - a change that would largely benefit the wealthy. This followed hard on the heels of a
decision to sharply raise payroll taxes, the most regressive federal levy. … The United States
began its long dramatic move away from the established practice of using taxes as an instrument
for tempering market-generated inequalities associated with the outsized earnings of those at the
top. At the same time, Congress and the President embarked on a major shift in economic policy,
embracing the argument that excessive regulation had become a serious impediment to growth.
(Hacker and Pierson, pp. 99-100)9
By 1980, the country had come to a cross roads. The existing set of government
institutions and policies, in combination with the increasing globalization of production,
investment and finance, and rising foreign competition, were no longer generating the
widespread prosperity the public had come to expect - though the 1970s turned out to be better
than the 1980s for the bottom two-thirds of the income distribution. Either we had to reconstruct
and reinvigorate our social democratic model or replace it with an alternative model. Right-wing
forces had a clear vision of the alternative model they wanted - a modern version of the 1920s
model situated in a globalized economic system - and had vastly increased their political clout.
Supporters of the basic New Deal philosophy were confused about how to restructure the
9
The transformation of the Democratic Party continued in the early 1980s. "Forced to deal with a much more
organized and assertive business community and facing powerful financial incentives to seek accommodation, the
Democratic Party apparatus reached out to corporate donors as never before. … Many in the Party were increasingly
eager to identify themselves as "business Democrats" - an identify they reinforced by voting in large numbers for the
massive business tax cuts of 1981 (Hacker and Pierson, p. 177).
11government-economy nexus in the face of economic adversity, and a large and growing
percentage of Democrats had abandoned the whole New Deal project, reinvented themselves as
business-oriented 'centrists.'10
Progressive academics and politicians did offer proposals to deal with the main economic
problems of the era that were consistent with the New Deal philosophy. The late 1970s
temporary inflation spike (which, in the absence of a third OPEC price shock, would have
petered out in a relatively short period) could have been met with temporary wage-price controls.
Instead, Fed policies drove interest rates through the roof and created massive unemployment
and the devastation of our industrial base.11 Financial chaos could have been ended by a
reconstitution of effective financial market regulation to deal with the changes that had taken
place over the period, rather than by the deregulation and globalization of finance actually
adopted.12 We could have instituted industrial policies to facilitate the expansion of our domestic
manufacturing system and the creation of more well-paying jobs, rather than decimate our
industrial base through high interest rates, a rising value of the dollar, and globalization. We
could have adopted a Canadian- or European-style health care system rather than accommodate
the growth of the most cost-ineffective system in the industrialized world. We could have
adopted policies that made it less attractive to US-based transnational corporations to flee the
country for cheap labor in the under-developed world. We could have strengthened the union
movement rather than adopt policies that led to its decline. We could have increased the tax base
through progressive tax increases and used the additional revenue to protect the social safety net
and increase productive government investment. A combination of stronger unions, a rising
minimum wage, tougher regulation of financial markets, and more progressive tax policy could
have sustained the relatively low inequality of the Golden Age. Instead, under the policies
10
Many Democrats have aligned themselves with extreme right-wing Republicans in the current austerity wars. For
example, when the Republican-controlled House recently rejected a proposed bill to raise the federal borrowing
limit in order to force President Obama to accept even more cuts in social programs, 88 Democrats voted with them
and seven more voted "present" (The Wall Street Journal, "House Soundly Rejects Increase in Debt Limit," June 1,
2011.
11
The second inflation spike was met by Paul Volcker's iron-fisted monetary policy that raised real interest rates to
historically high levels, which caused the exchange value of the dollar to spike. Both effects combined to decimate
the Midwest manufacturing base, creating what was called a "rust belt." The unemployment rate rose to almost 10%
in 1982 and 1983 and remained at 7% or higher for seven straight years, further debilitating the union movement
12
The decision to radically deregulate financial markets taken in the 1980s accelerated a process that eventually
culminated in the financial catastrophe that erupted in 2008.
12adopted after the late 1970s, the degree of inequality exploded to levels that matched their peak
in the late 1920s.
The main point is that, in contrast to Margaret Thatcher's dictum that there is no
alternative to unregulated, globally-integrated capitalism, there are always many paths available
to a mixed economy. But in the economic, political and cultural milieu of the late 1970s, it was
the model favored by the right-wing coalition that was gaining political and ideological power.
The election of Ronald Reagan as President in 1980 represented a major victory for right-
wing forces. He famously ridiculed the New Deal idea that the government could play a useful
role in the economy: “Government is not a solution to our problem,” he said, “government is the
problem.” In concert with a complaint Congress controlled by Democrats, Reagan implemented
policies that constituted a major step toward the creation of a modern version of the 1920s
model, a model that became known as global neoliberalism or global neoliberal capitalism. He
restricted the growth of government spending on the poor and middle class and simultaneously
instituted large tax cuts focused on corporations and the very wealthy.13 Reagan attacked the
union movement. He struck the first blow when he fired the air traffic controllers when they
went on strike in 1981. But he also packed the labor regulatory system with anti-union
individuals and supported the appointment of pro-business, anti-labor Federal judges. The
massive unemployment of the first half of the 1980s further undercut union strength. By 1989
only 16% of workers were in unions.
Under Reagan, the government accelerated the deregulation of business. Financial
market deregulation was especially dramatic. The combination of financial market deregulation,
high unemployment, regressive tax cuts, and attacks on unions inevitably triggered a rapid rise in
inequality. The share of income captured by the top 1% of the income distribution increased by
about 50% during the Reagan years. Moreover, the freedom of capital investment, trade and
finance to roam the globe with little hindrance from government cross-border restrictions
increased qualitatively during the Reagan years. Globalization gave mobile industrial capital a
huge advantage over immobile domestic labor by increasing the threat that firms would shift
production outside the country unless workers accepted lower wages and benefits, became more
13
Gains from these tax cuts in the bottom half of the income distribution were erased by increases in Social Security
and Medicare taxes.
13compliant, and disavowed unions. It also made it easier for US firms to produce both capital and
consumer goods elsewhere and then import them back into the US for sale. The US experienced
massive trade deficits from the 1980s onward. Increased capital mobility also facilitated a ‘race
to the bottom’ in which transnational firms threatened to invest only in those countries with the
lowest corporate taxes and least effective regulatory regimes. Reagan thus made substantial
progress in pursuit of a new 1920s regime.
Since Reagan not only cut taxes but also increased defense spending by about 1.5% of
GDP, he created the largest federal budget deficits since the end of World War II. The largest-
post-war deficit prior to Reagan was 4.2% of GDP in 1976. Indeed, there were only three years
since World War II in which the deficit was 3.0% or more of GDP until the Reagan
administration, and they were all in the aftermath of the first OPEC oil price hike. But from 1982
through 1987, annual deficits averaged 5.9 % of GDP and from 1982 through 1989 they were
never less than 5.6%. Indeed, the deficits were so large that Reagan supported several tax laws
that increased revenues, the most important of which was enacted in 1986. The 1986 law cut the
maximum tax rate on corporate income, but also eliminated many tax loopholes. The immediate
impact was to raise corporate tax revenue. However, it should come as no surprise that the low
tax rate stayed in place in subsequent years while lobbyists stuffed the tax code with new
loopholes under both Republican and Democratic Presidents. This lowered the effective
corporate tax rate and drained tax revenues. "If you take a good look at the tax code now, you'll
see that it is chock-full of new tax breaks, far more expensive than the ones eliminated with such
fanfare [in 1986]" (Hacker and Pierson, p. 109).
The general direction of the policies adopted in the Reagan years continued during the
presidency of George Bush senior. Right-wing forces continued to grow stronger and Democrats
continued their rightward drift. Bill Clinton campaigned as a progressive in the 1992 presidential
election, but governed as a pro-business centrist.14 The Democrats lost the House and Senate in
1994. They had controlled the House since the mid 1950s. The House leadership - men such as
Newt Gingrich, Dick Army, and Tom Delay - were by far the most radical right-wing group to
control the House in the post World War II era. This was the kind of Republican Party that
14
Bob Woodward's book The Agenda: Inside the Clinton White House (Simon and Schuster 1994) describes this
shift in detail.
14Eisenhower predicted could never get elected. Moderate Republicans were now an endangered
species, while the Democratic Party was to the right of Eisenhower and Nixon on economic
issues.
Clinton's record on the economy was mixed. He did preside over a rapid economic
expansion in the second half of the1990s that drove the rate of unemployment below 5% for the
first time since 1970. In 2000, the unemployment rate was 4.0%, yet inflation remained at
modest levels. And he orchestrated a modest increase in the tax rates on upper incomes that,
together with rapid economic growth, led to the first budget surpluses since 1969 in the last three
years of his presidency. But there were serious economic problems as well. First, the expansion
was driven by several unsustainable forces whose collapse triggered a recession as soon as he
left office: an internet bubble, a telecommunications bubble, and a stock market bubble that was
kept alive after 1997 by an epidemic of phony corporate accounting designed to hide the fact that
corporate profits were in decline. Second, he supported and achieved substantial additional
financial market deregulation that directly contributed to the financial market collapse in 2008.
Third, he seriously weakened the welfare system. Fourth, Clinton continued the globalization
process by forcing the North American Free Trade Agreement through Congress against the
strong opposition of the union movement and a substantial segment of the Democratic Party, and
by helping establish the World Trade Organization. Fifth, inequality rose significantly on his
watch. The income share of the top 1% of the income distribution rose from 15% to 22% during
his presidency.15
By the end of Clinton's presidency, union membership was down to 13.5% of the
workforce. While other social groups that lent support to Democratic candidates had grown since
the 1970s, including the women's and environmental movements, none of them focused on
political actions in support of the economic interests of the bottom two-thirds of the income
distribution with the intensity and effectiveness of unions. The forces attempting to destroy the
New Deal were meeting ever weaker resistance.
George W. Bush took office in 2001, just as the bubbles that sustained growth in late
1990s deflated, sending the economy into recession. Under his presidency, the Republican Party
15
See http://www.stateofworkingamerica.org/charts/view/155.
15intensified the war against the New Deal so successfully that there is some possibility that final
victory may be in sight. Bush oversaw the passage of very large regressive tax cuts that
hemorrhaged trillions of dollars of government revenue. In 2007, Citizens for Tax Justice
estimated that the top 1% would receive 38% of the cuts over a decade.16 In fact, the top 1% did
receive 38% of the cuts in 2010.17 Bush also started wars of choice in Iraq and Afghanistan,
which have been very costly to date, and will ultimately cost trillions of dollars. Revenue was
also constrained by the extremely weak growth of the economy under Bush. For example, in
2008, inflation-adjusted median family income was lower than it had been a decade before, the
first time this had happened in the post World War II era. Tax cuts, costly wars and a sluggish
economy alone would have turned Clinton's surpluses into large deficits. But financial markets
imploded in 2008, kicking the weak economic recovery into a tailspin. The economic collapse
slashed government revenue and automatically triggered greater spending on programs such as
unemployment compensation and Medicaid. Fearing that the global financial system would itself
collapse unless drastic action was taken, the government committed about $12 trillion to support
financial markets. It also undertook a substantial deficit-financed stimulus program to try to
prevent the deep downturn from turning into a bottomless depression.
The failed right-wing economic model combined with the reckless policies of George W.
Bush and the Obama administration's efforts to prevent a depression created by far the largest
federal budget deficits in peacetime history just after Obama took office. A reasonable person
might think that the policies chosen to reduce or eliminate these deficits would be designed to
attack their underlying causes. But that's not what happened. The debate between Democrats and
Republicans is over how to deal with the deficit crisis is based on the blatantly false assumption
that there are large deficits because “we” - the American people - are greedy and have demanded
levels of government spending that we will not and cannot pay for. As a former Republican
Senator from Utah and co-chair of President Obama's committee to find solutions to prospective
shortfalls in Social Security revenue put it: Social Security "is like a milk cow with 310 million
tits." Since the problem is caused by the American people sucking the government dry, the
argument goes, the obvious solution is to drastically slash excessive government nondefense
16
Citizens for Tax Justice, "The Bush Tax Cuts: The Latest CTJ Projections," March 2007.
17
A. Fieldhouse and E. Pollack, "Tenth Anniversary of the Bush-Era Tax Cuts," Economic Policy Institute Policy
Memorandum 184, June 1,2011.
16spending by enough to eliminate the deficits. Raising tax rates is anathema to the Republicans,
and President Obama has proposed only modest tax increases for those with the highest incomes.
In effect, almost all the deficit reduction work is expected to come through nondefense spending
cuts, a long-term objective of the right-wing coalition. 2007 was the last year before the crisis hit
the economy and caused government spending to rise dramatically. The $1.3 trillion that would
be needed to eliminate the 2010 deficit is 47% of all government spending in 2007, including
Medicare, Medicaid, Social Security and defense. To insist that deficit reduction come almost
exclusively through spending cuts is tantamount to demanding the destruction of the social safety
net and public investment.
To make matters worse, in 2010 President Obama and Congress agreed to extend the
Bush tax cuts for two more years at an estimated revenue loss of $850 billion. The top 1% of
taxpayers is expected to get 25% of the tax cuts, while the bottom 40% get just 9%. President
Obama is committed to the perpetual extension of these cuts on the first $250,000 of income for
all families.18
So instead of solving our fiscal problems by eliminating the causes of the deficit, the
political process - dominated by a coalition of right-wing Republicans and conservative
Democrats that dances to the tune of the oligarchs who fund them - used the deficit crisis to
unleash an austerity war against the American people.
Phillips-Fein concluded her study of the long-struggle by the right to undo the New Deal
as follows: "The political cause for which [the anti-New-Deal forces have] labored has in large
part been triumphant: the New Deal has been turned back” (p. 322).
3. The Main Effects of the Right-Wing Economic Model Were Slower Economic Growth,
Increased Inequality, and Rising Deficits.
18
Citizens for Tax Justice, “Compromise Tax Cut Plan Heavily Tilts in Favor of the Well-Off," December 10, 2010.
Obama vowed to limit these cuts to the first $250,000 of family income - that is apparently his definition of the
upper end of the "middle class." But because he gave in to Republican demands in 2010 to remove the income limit,
there is no reason to believe he will not extend them after 2012 since the Republicans now have greater influence in
Congress.
Note that there are good reasons to continue to stimulate our broken economy through deficit-financed
spending on public investment and social programs, but not to cut rich people's taxes. The reductions to the tax
burden of the bottom half of the income distribution in the Bush-Obama tax cuts are so modest that this group would
be much better served by fixing the problems in the economy that caused the deficit explosion.
17The rate of economic growth has slowed substantially and the degree of inequality has
skyrocketed since the economic regime change that began in the late 1970s. While there may be
causes in addition to the shift in economic models that contributed to this decline, the facts of
decline are quite clear. The growth rate of real GDP was 3.75% a year from 1950 through 1979,
but only 2.75% a year from 1979 through 2010.19 Figure 1 presents data on market-generated
incomes; it does not include the effects of government transfer payments such as Social Security
or unemployment compensation. It shows that real per capita income grew much more rapidly in
the years from 1946 to 1976 than it did from 1976 to 2007, and that the average income of the
bottom 90% grew much faster than that of the top 1% in the earlier period. However, while per
capita real GDP increased by 66% in the latter period, the average market income of the bottom
90% grew by a paltry 8%, while the average income of the top 1% increased by a spectacular
280%.20 In the expansion of 2002-07, the top 1% had inflation-adjusted income gains of 61.8%,
the super rich in the top 0.01% saw their income rise by 94.1%, but the bottom 90% had gains of
just 3.9%.21 The Bush expansion made the late 1920s look egalitarian.
Figure 2 presents data on the growth of real family income by fifths or quintiles. The
income measure used here includes government transfer payments but excludes capital gains,
which accrue primarily to those in the highest income brackets. Two facts stand out. First, the
rate of growth of real family income was much higher during the period in which New Deal
programs were expanding than it was as the foundations of the New Deal began to erode after
the late 1970s. For the bottom 80% of the income distribution the differences between the
periods are stunning. Second, the distribution of income gains was much more unequal in the
latter period. In the first period the highest rate of growth was in the lowest quintile and the
lowest growth was in the highest quintile. In the post-1979 era, the poorest quintile actually
19
This paper argues that higher growth is needed to improve conditions in the labor market and raise the rate of
growth of tax revenues. But more rapid growth under current conditions will exacerbate environmental problems,
contribute to global warming and over-utilize non-renewable resources. We need an economic model that takes
these problems into account. Conversion to such a model could add to both growth and employment. See, for
example, Robert Pollin, James Heintz and Heidi Garrett-Peltier, "The Economic Benefits of Investing in Clean
Energy," Center For American Progress, June 2009.
20
Center on Budget and Policy Priorities, "Testimony of Robert Greenspan President, Center on Budget and Policy
Priorities Before the Senate Committee on Budget," May 9, 2011.
21
Center on Budget and Policy Priorities, "Top 1 Percent of Americans Reaped Two-Thirds of Income Gains in Last
Economic Expansion," September 9, 2009.
18suffered a decline in real family income, the second poorest quintile had near zero growth, and
the highest quintile had by far the highest growth rate.
The use of quintiles hides the fact that the rise in inequality is concentrated at the very
top of the income distribution. For example, from 1979 to 2007 the top 1% received a higher
share of income growth than did bottom 90%, an outcome that would have been unthinkable
prior to the Reagan revolution.22 The share of market income (including capital gains) received
by the top 1% hit a peak of 23.9% at the height of the late 1920s financial boom. It fell
dramatically after 1929 and stayed at about 10% throughout the Golden Age. However, precisely
when right-wing political forces began to strengthen in the 1980s this index of inequality began a
prolonged rise that took it to 23.5% in 2007, just before the financial bubble burst.23 The top
0.01% received 6% of market income in 2007, which was higher than the previous peak in 1928
and 1929.24 The spectacular rise in the share of income received by the very rich helps explain
why there was no political backlash against the sluggish growth rates generated by the new
economic model. Inequality was rising fast enough to generate fabulous rates of income growth
for economic and political elites even as the overall rate of economic growth declined. Since
these elites used their wealth to control the political process, there was no effective opposition to
the evolving right-wing economic model. Our political system had again, as in the late 1920s,
become an oligarchy.
Figure 3 shows the effects of regime change on a typical American family. It focuses on
the real or inflation-adjusted value of income for the median family - the one in the middle of the
income distribution. Medium income more than doubled from 1947 to 1979, reflecting the
enormous improvement in the economic conditions of ordinary Americas in the New Deal era.
But income growth slowed dramatically as the New Deal model began to erode. Median income
in 1993 barely exceeded its 1979 value. It then increased by almost 17% in the Clinton
expansion. Median income actually declined by 3% during the presidency of George W. Bush.
After rising by 2.4% a year in the period from 1950 to 1979, median family income increased by
a meager 0.04% annually in the 1979 to 2009 period. The rate of change would have been
22
See http://www.stateofworkingamerica.org/charts/view/82.
23
Hacker and Pierson estimate that about 38% of the rise in the income share of the top 1% from 1970 to 2004 was
created by tax cuts (p. 49).
24
T. Piketty and E. Saez, "Striking it Richer: The Evolution of Top Incomes in the United States (Updates with 2007
Estimates)," August 5, 2009. At: http://elsa.berkeley.edu/~saez/saez-UStopincomes-2007.pdf.
19negative if not for the growth in hours worked per family after 1979. Real GDP grew at 2.75% a
year in the neoliberal era and labor productivity grew by about 1.6% annually (after growing
2.5% per year from 1953-1979), but because of the structure of the new economic model, poor
and middle class Americans failed to share in this growth.
4. The Right-Wing Economic Model and Wars Caused the Deficit Crisis.
Since the right-wing economic model relentlessly pursues regressive tax cuts and reduces
the economic growth rate, it has a strong structural tendency to restrain the growth of
government tax revenues. While it is committed to reducing government spending on the social
safety net and public investment, it supports increased defense expenditures and projects that are,
in reality, handouts to corporate America. Moreover, proposals by conservative politicians to
defund or privatize popular spending programs such as Social Security and Medicare have, until
now, triggered a powerful political backlash that makes them difficult to implement. George W.
Bush's attempt to privatize Social Security was met with such resistance that he withdrew his
proposal. In practice, at least until now, the model restrains revenue growth more effectively
than it lowers spending. This combination of attributes makes rising deficits a structural
attribute of the right-wing model.
The historical record confirms this assertion. Federal government debt in the hands of the
public as a percentage of GDP is the variable used to measure the extent of government
indebtedness. This ratio peaked at 112% in 1946 just after the war ended. During the early post
World War II decades, the rate of economic growth was much faster than the rate of growth of
government debt, so the debt to GDP ratio became smaller over time. In the year before Ronald
Reagan became president, the ratio was at a post-war low of 26%. There was no deficit or debt
problem before the Reagan presidency. When Reagan left office in 1988, the debt to GDP ratio
had risen to 41% - a jump of almost 60 percent. During the presidency of George Bush senior it
rose to 48.1%, almost double what it had been in 1981. The debt ratio fell from 49.3% to 34.7%
in the Clinton years, as the rate of economic growth accelerated and tax rates on the rich were
modestly increased. The federal government even ran surpluses in the final three years of his
presidency.
20Indeed, when George W. Bush took office in January 2001, the Congressional Budget
Office (CBO), the bipartisan group charged with assessing the prospective budget implications
of all tax and spending legislation, estimated that under then-current policies (including the tax
rates carried over from the Clinton administration) the federal government would run ever-rising
surpluses over the next decade. The cumulative surpluses were projected to be $5.6 trillion.25
These estimates took increasing problems with Social Security and Medicare and Medicaid
funding into account. At the time of these estimates in 2001, the total debt held by the public,
accumulated from the birth of the nation, was only $3.3 trillion. We appeared to be on the verge
of eliminating all federal debt.
But rather than applaud this prospect, many conservative economists and politicians
expressed concern that these surpluses could be dangerous since they would drain the Treasury
bond market, which plays an important role in the financial system. From their perspective, the
best way to deal with the “problem” of rising surpluses, of course, was to cut taxes. Federal
Reserve Chairman Alan Greenspan argued that it would be better to slash taxes than to pay off
the debt: “In 2001, with the government running a surplus, Mr. Greenspan lent support to
President Bush’s tax cuts, to the consternation of Democrats” (Wall Street Journal, “Former Fed
Chief Greenspan Favors Clinton-Era Tax Rates," June 4/5, 2011).
The actual and prospective surpluses were thus converted into huge deficits by the
massive Bush tax cuts and other policies. In fact, the decade from 2001-2011 saw a cumulative
$4.7 trillion deficit - a $10.3 trillion deterioration from the CBO's 2001 projection. The Bush
Administration understood that the trillions of dollars in tax revenue likely to be lost over a
decade by such large tax cuts would generate substantial budget deficits. In fact, these tax cuts
resulted in $3 trillion is lost revenue from 2001-2010.26 But right-wing political strategists
considered this to be a benefit of the policy. Paul Krugman commented in 2003 that the tax cuts
were:
so large that the nation can't possibly afford it while keeping its other [spending]
promises. But then maybe that's the point. The Financial Times suggests that "more
extreme Republicans" actually want a fiscal train wreck: "Proposing to slash spending,
25
Congressional Budget Office, "The Budget and Economic Outlook: Fiscal Years 2002-2011," January 31, 2001.
26
A. Fieldhouse and E. Pollack, "Tenth Anniversary of the Bush-Era Tax Cuts," Economic Policy Institute Policy
Memorandum 184, June 1, 2011.
21particularly on social programs, is a tricky electoral proposition, but a fiscal crisis offers
the tantalizing prospect of forcing such cuts through the back door. It's no secret that
right-wing ideologues want to abolish programs Americans take for granted. (New York
Times, "Stating the Obvious," May 27, 2003)
In the year George W. Bush took office, the debt to GDP ratio was 32.5%. When he left
office in 2008, the ratio was 40.3%, but the deficit was about to explode. President Bush had cut
taxes and fought expensive and unnecessary wars. Joseph Stiglitz and Linda Bilmes estimate the
ultimate cost of the Iraq war alone to be $3 trillion.27 He also left an economy about to implode.
The disastrous financial crisis made possible by radical deregulation triggered an economic
collapse serious enough to potentially generate a depression. In the first year of President
Obama’s term, as the economic crisis deepened, the ratio hit 53.5%. In 2010 it was 62.5%. The
deficit was projected to hit 75.1% in 2012, in part due to the two-year extension of the Bush tax
cuts agreed to by President Obama and Congressional Republicans in 2010. But if all the Bush
tax cuts are again extended after 2012, as is quite possible, the figure would rise to about 95% in
a decade.
The size of the annual deficit is the sum of interest payments on existing debt plus the
“primary” surplus or deficit - the difference between revenues and all expenditures other than
interest payments. When the debt to GDP ratio becomes very large, interest payments may
become so big that the budget will remain in substantial deficit even if there is a large primary
surplus. For example, in the CBO projections of January 2011(which assume the Bush tax cuts
end after 2012), the primary budget is in surplus after 2017, but interest payments keep rising,
hitting almost $800 billion in 2021, causing a projected deficit of $763 billion that year. This is
the legacy left by the administration of George W. Bush. The deficit cannot be eliminated just by
bringing revenues and spending into balance; we would have to cut spending and/or raise
revenues by enough that the primary surplus covers large interest payments, and these payments
will increase substantially if interest rates rise above their current low levels. Thus, the soaring
deficits created by the Bush administration will continue to generate pressure for austerity for a
very long time, even if the primary budget is eventually balanced. This is part of the perverse
genius of the “starve the beast” strategy.
27
“All told, the bill for the Iraq war is likely to top $3 trillion. And that's a conservative estimate” (Linda Bilmes and
Joseph Stiglitz, Washington Post, “The Iraq War Will Cost Us $3 Trillion, and Much More,” March 9, 2008.)
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